Why Private Equity Shops are Recapitalizing Banks

Many banks are raising capital these days; the latest to hit the headlines are Washington Mutual, raising $7 billion from TPG, and National City, which is getting something north of $7 billion from a syndicate led by Corsair Capital. Such bilateral deals seem to be more common than the alternative route, taken by Wachovia, of going to the public markets.

Why would banks choose to limit themselves to a small number of sovereign wealth funds or private-equity shops, rather than the millions of potential investors in the stock and bond markets? After all, it’s not as though the big investors can’t subscribe to a public offering if they’re so inclined.

Roger Ehrenberg has a theory on this: that the big funds are jumping in too early, desperate to justify their existence.

I applaud the guts-of-steel necessary to invest in the face of financial panic. The problem is, I just don’t see the panic reflected in the U.S. stock market, notwithstanding all the issues with the global credit markets. And I know that these private equity firms and the SWFs say that they are getting quality assets on the cheap. But I worry about the conflict between the ability and desire to write a big check and the best time to write such a check…

It takes incomprehensible amounts of discipline to let ok deals (from a risk/return perspective) go by in order to wait for the truly great deals with solid margins of safety to present themselves. Because it can get pretty embarrassing sitting on $10 billion (or in the case of SWFs, $100 billion or more) of commitments, getting paid management fees and not putting money to work. There is a natural pressure to pull the trigger, because it may be more painful waiting for the right deal to come along than doing a deal that ends up being mediocre but being busy in the process. And it certainly is impossible to raise a fund V, VIII or XII if one can’t even get past 50% of committed capital for the current fund. This would bring the whole asset gathering operation to a screeching halt. And we can’t have that, can we?

I’m not sure how much this argument works in the case of SWFs, but it does make a lot of sense with respect to the private-equity shops. The bank recapitalizations are one of the few areas where it’s possible to invest multibillion-dollar sums right now on a leveraged basis (all banks, by their nature, are leveraged) without having to actually borrow money from someone. It might even be the case that the private-equity funds need these bank investments more than the banks need the funds – with the implication that the funds are overpaying.

This, of course, is great news for the financial-services industry as a whole: it is being recapitalized by private-equity shops at a time when the public markets are very reluctant to throw good money after bad. The only losers are likely to be the limited partners in the PE funds, and no one’s going to shed too many tears for them.